On 18 November, The Carlyle Group purchased Churchill Financial from Olympus Partners, capitalising on the opportunity to back a mid-market lender when financing for medium-sized businesses is in short supply.
Churchill provides senior secured debt to mid-market companies, lending out of a $1.25 billion collateralised loan obligation structure owned by Churchill Financial Group, which remains a portfolio company of Olympus Partners. Churchill was formed in 2006 when Bear Stearns Merchant Banking teamed up with Churchill Capital to form the commercial finance outfit. It has funded more than $1 billion in loans.
The investment in Churchill could be seen as just another example of Carlyle expanding its platform to every corner of the market, but the private equity giant’s acquisition also highlights the increasingly attractive light that has been cast on mid-market lenders in the current climate. With capital-constrained US banks no longer a primary source of available financing, mid-market lenders are the next lifeline for liquidity.
“The traditional lenders in this space have retrenched, which has created a supply-demand imbalance,” Ted Koenig, president and chief executive of Chicago-based Monroe Capital, told Private Equity International. “As a result, businesses have been turning to mid-market lenders to fill the void. That’s helped fill the supply-demand imbalance,” he said.
From a lender’s perspective, the proposition of partnering with a private equity firm should be a fundamentally attractive opportunity, according to Koenig.
“More players means more liquidity,” he said. “It’s better for everyone.”
Monroe closed a $250 million fund focused on mid-market debt investments in March, and after seven months had deployed roughly half of the fund.
On the other side of the table, private equity firms should have mid-market lenders on their radar now more than ever, according to Charles Davis, chief executive officer of Connecticut-based private equity firm Stone Point Capital.
“It’s a very attractive time for mid-market lending,” Davis said. “The big banks aren’t generally dipping down to the smaller areas, the little banks are afraid to loan money and many of the traditional mid-market lenders are not as aggressive as they once were.”
Stone Point, which invests exclusively in financial services, recently received a co-investment from The Teachers’ Retirement System of the State of Illinois of up to $40 million in mid-market finance company NXT Capital, which Stone Point acquired in April 2010.
One challenge for private equity firms lies in identifying promising lenders in which to invest, as many mid-market lenders already have private equity sponsors.
“I think the train may have [already] left the station, only because you’ve got a few good mid-market lenders, and the market is not as deep and wide as the broad market,” Koenig said.
James Treanor, head of capital markets for hedge funds at Minnesota-based institutional investor advisor Jeffrey Slocum & Associates, agrees.
“I think a lot of the better groups, if they wanted to sell, they probably already have,” he said.
Private equity firms are very smart investors, but one of the things they need is a clearly defined exit strategy. It’s hard to realise a good exit in this space
“Private equity firms are very smart investors, but one of the things they need is a clearly defined exit strategy,” Koenig said. “It’s hard to realise a good exit in this space.”
Limited partners, however, don’t necessarily feel it’s too late to capitalise on such opportunities.
“I think generally, some LPs are willing to go illiquid in strategies like this if they think they will be paid for lack of liquidity,” Treanor said. “That is a general theme in the market today for big pension funds that don’t have pressing cash flow needs.”
A possible development in 2012 could be an increase in private equity firms backing debt team spin-outs, according to Treanor.
“I think there are a lot of synergies between private equity firms and building out a debt platform. If you get teams that spin out, not necessarily mid-market lenders but credit groups in general, that might present some opportunities,” he said. “KKR did that with the team that left Goldman Sachs recently, so I think you might see more of those.”